Secrets of the Tax-Prep Business

What do refund lenders see when they look at poor neighborhoods?

It was Meister's rotten luck that in December 2009, only weeks before he was to open, federal regulators ordered Santa Barbara Bank & Trust out of the RAL business. Although tax loans were its most profitable division, the bank had taken huge losses in the subprime meltdown and had failed to meet its capital requirements. It was Santa Barbara that underwrote the RALs Instant Tax offered, and it was too late to find another bank.

So Meister adapted. The sign in his window read, "Stop in, get your taxes done, and leave with TaxCash the same day!" But when anyone inquired about a RAL, he pontificated about the banking crisis and how credit had basically dried up for everyone. "There might be some stores advertising it," he said (to me and anyone who stopped in), "but the reality is that few will actually get a refund anticipation loan." In fact, competitors down the street were still offering RALs—small businesses and the middle class may have been starved for credit, but banks were still more than willing to play emergency banker to the working poor, at least when the loans were more or less guaranteed by the IRS. Meister was similarly evasive about pricing. "A couple of hundred dollars," he'd say, though invariably he charged $300 and up. When I pressed him, Meister insisted that he was charging around $200, but there was a $59 e-filing fee and a $100 "technology" fee that went to the company licensing its software to Instant Tax. (Ogbazion told me the software company charged $17 per return, not $100.)

One customer who bought Meister's services early that January was Fred B. Newman, a custodian at a local hospital. A father of two, Newman anticipated a refund of around $4,000. He was behind on his electric bill and carrying a balance on a high-rate credit card. "Nothing too bad," he said, though he wanted his money as fast as possible. Meister, unable to offer him a RAL, talked him instead into buying something called a refund anticipation check, or RAC.

It wasn't clear why Newman would pay $42 for a RAC, which doesn't ensure an instant refund. The RAC is meant for customers who lack bank accounts or who can't afford to pay up front for tax preparation—it's basically a charge for a temporary account where the IRS can deposit the refund, and from which a preparer can deduct his fees. Newman already had a checking account and a means of payment, but Meister put him down for a RAC without bothering to explain its purpose. "I can make that $42 go away if you don't mind waiting on the IRS," he said when Newman noticed the extra charge. He added that if Newman was worried about the price (his bill now totaled almost $400), he could simply wait six to eight weeks—the time it takes for a check to arrive when you're filing by mail.

"I can't wait that long."

"It's your call," Meister replied.

In fact, Newman was already paying Meister an e-filing fee and thus, according to the IRS, would be getting his money no more than 15 days after filing—with or without a RAC.

AT THE TIME, Meister told me he hoped to open a dozen or more Instant Tax shops around New York. In the end, though, he gave up after only one tax season; 2010 was a miserable year, in no small part because he couldn't offer the refund loans. Jackson Hewitt also relied on Santa Barbara for some of its loan volume, so half of its stores were unable to offer a refund loan last year.

While bank regulators in Washington have stopped short of outlawing refund loans, they've managed to make life more difficult—and therefore less profitable—for the banks.

The post-subprime environment has been tough for low-rent tax preparers. "The current administration does not look favorably on these products," says Vishnu Lekraj, a stock analyst who follows the tax-prep chains for Morningstar. While bank regulators in Washington have stopped short of outlawing RALs, they've managed to make life more difficult—and therefore less profitable—for the banks. The new official line is that so long as tax preparers are selling these loans, the banks must supervise them more closely: Put better audits in place. Make sure they adequately train their people. Monitor their marketing efforts. Last April, shortly after the end of the 2010 tax season, JPMorgan Chase announced it was getting out of refund loans altogether, leaving 13,000 independents, including Ramon Dalmasi, scrambling for an alternative lender.

The industry took an even bigger punch in August, when the IRS announced it would stop providing lenders with a "debt indicator" letting them know whether a taxpayer was likely to have a refund garnished for back taxes or other debts. ("It's a product provided by the private sector," IRS spokesman Dean Patterson said of the RAL, though he declined to explain the agency's decision. "We neither endorse it nor try to dissuade people from using it.") In the past, according to a study by one consumer group, the IRS gave the thumbs-down to at least 1 in 12 people seeking a refund loan. Without that handy information, these loans are much riskier. HSBC, the London-based bank that was under contract with H&R Block to underwrite tax loans through 2013, announced that without the debt indicator, it was getting out of the RAL business. Block sued, and the two parties came to an agreement, but then, just weeks before the start of the current tax season, federal regulators told HSBC it could no longer offer RALs. The feds offered no official explanation, leaving consumer advocates to wonder whether the bank had used its government connections to extract itself from a business that suddenly looked a lot less profitable.